Saturday, February 6, 2016

Barron's Cover: "Here Comes $20 Oil"

On the other hand there are so many bets on the short side that any change in psychology can result in a 10% daily up-move as we saw on Feb. 3.

Here's Barron's:

Oil could fall as low as $20 a barrel in the
first half of this year, recovering to $55 by year end. That could help
drive stocks, which have closely followed oil prices, much higher.

Oil bulls, take heart. The last leg of the
bear market that began in mid-2014 is probably in sight, as marginal
producers fall by the wayside. Supply cutbacks should bring a rebound in
the price of crude by the second half of 2016.

But
before a rebound, West Texas Intermediate crude will probably continue
to fall, perhaps as low as $20 a barrel, before vaulting to the mid-$50s
by year end.

Stock market investors can
also take heart. The stock indexes have been closely correlated with
oil of late, moving up or (mostly) down, as the price of crude has
gyrated. This perverse pattern has persisted even though the
overwhelming majority of global companies benefit from cheaper crude,
since they buy the refined products to help run their operations.

It’s
true that many oil exporters are in emerging market economies, and low
oil prices have slowed their economic growth and put a dent in their
sovereign wealth funds. Beyond this, stock traders may be subscribing to
the misguided belief that low oil prices are signaling imminent global
recession.

Our expected recovery in
crude by the second half of this year will, therefore, probably bring a
recovery in equities. And perhaps even before then, stock traders might
wake up to the fact that the bear market in oil has mainly been
reflecting a world awash in black gold.

While
global weakness on the demand side has played a part in the buildup of
excess supply, it has been weakness in the rate of growth, not an
outright economic contraction. A further slowdown in global growth,
especially from China, will also play a role, but here again, the supply
side will dominate, as cutbacks in production bring a rebound in
prices.

Barron’s predicted $75 oil in late March of 2014,
when crude was trading above $100. But the market soon overshot our
contrarian forecast, as the slowdown in global growth curbed the growth
in demand. We followed up on that story repeatedly, lowering our sights
to $20 a barrel a year ago (see chart below).

WORLD CONSUMPTION OF OIL
has held up relatively well. It rose in 2014 to 92.8 million barrels a
day from 2013’s 91.9 million, a below-par increase of just 0.9 million
barrels. Consumption in 2015 rose to 94.5 million, for a relatively
substantial rise from 2014. But, of course, that was due mainly to the
price plunge that made oil dirt cheap.

For
2016, in no small part because of the expected economic slowdown in
China, Citigroup’s senior energy analyst Eric Lee projects below-par oil
demand growth of one million barrels a day, to 95.5 million.

The
supply side, then, has been the main driver of the oversupply that has
wrought the bear market. And nowhere has the supply-side revolution been
more dramatic than in the U.S. As recently as 2010, the U.S. produced
5.5 million barrels a day of oil. Due to the advent of hydraulic
fracturing, or fracking—the extraction of oil from shale—production
jumped to 8.7 million by 2014. In 2015, production set another record,
at 9.7 million....MORE